CLIENT ALERT: Delaware Bankruptcy Court Denies U.S. Trustee Quarterly Fees for Litigation Trust Distributions
Recently in the Paragon Offshore bankruptcy cases, Judge Sontchi addressed whether distributions of settlement proceeds from a litigation trust to the holders of the beneficial trust interests were disbursements for purposes of payment of fees to the Office of the United States Trustee under 28 U.C.S. § 1930(a). In re Paragon Offshore plc, et al., 16-10386- CSS, (Ltr. Rul. June 29, 2021); see Docket No. 2257.
Paragon Offshore plc (“Paragron”) filed for bankruptcy in the United States Bankruptcy Court for the District of Delaware (the “Court”) on February 14, 2016. Id. at 2. On May 2, 2017, Paragon filed its plan of reorganization (the “Plan”). See Docket No. 1614. Pursuant to the Plan, a litigation trust (the “Litigation Trust”) was established to distribute to certain creditors any proceeds from potential litigation against Noble Corporation plc (“Noble”) and certain other defendants stemming from a 2014 spin-off of old offshore drilling rigs by Noble to new subsidiaries, namely Paragon. Id. The Court confirmed the Plan on June 7, 2017 (the “Confirmation Order”). Ltr. Rul. at 2. During the quarter that Paragon transferred property into the Litigation Trust, between July 2017 and September 2017, Paragon’s distributions exceeded $623 million, and Paragon paid the maximum fee payable to the UST (defined below). Id. at 3.
On December 15, 2017, the Litigation Trust filed an adversary complaint to recover payments Paragon made to Noble. Id. In February of 2021 after months of mediation and Noble’s own bankruptcy filing, Noble, the other defendants and the Litigation Trust agreed to settle the case for $90,375,000. Id. at 4. The Court approved the settlement on February 24, 2021. Id. The Litigation Trust received the settlement proceeds in March of 2021. Id.
The Liquidation Trust sought to distribute the settlement proceeds immediately. However, the United States Trustee for Region 3 (the “UST”) argued that this would count as a “disbursement” under 28 U.S.C. § 1930(a)(6) and either Paragon or the Litigation Trust would need to pay the statutory fees. Section 1930(a)(6) requires the payment of a quarterly fee for each quarter that a bankruptcy case is open, and the fee increases or decreases depending on the amount of disbursements made in the bankruptcy case for the applicable quarter. On May 12, 2021, the UST filed a motion to compel seeking $250,000 in statutory fees from either the Paragon Debtors or the Litigation Trust (the “Motion to Compel”). Id.
The parties briefed the issue, and the Court held a hearing on the UST’s Motion to Compel on June 10, 2021. The UST argued that, while this is technically not a disbursement made by Paragon, the Litigation Trust doesn’t exist in a vacuum and that it was created by and exists to facilitate the Plan. Therefore, these payments are sufficiently tied to Paragon to trigger statutory fees. The Litigation Trust and Paragon argued that the distribution of the settlement proceeds would not be a payment by or on behalf of a debtor, as the Litigation Trust is a separate entity.
The Court ultimately denied the UST’s Motion to Compel for payment of any further fees. The Court reviewed case law on the definition of “disbursements” as used in 28 U.S.C. 1930(a)(6) noting that “several circuits define disbursements as all payments by or on behalf of a debtor [and] . . . commonly understood in this context to apply to payments made with the funds generated from the liquidation of the debtor’s assets.” Id. at 4 (internal quotations omitted). The Court identified as a common thread “the fact that the debtor had some interest in, or control over, the money disbursed.” Id. The Court reasoned that a distribution is “the ultimate payment of the expense by any entity on behalf of a debtor that is the subject of quarterly fees” and agreed that the Litigation Trust was not paying expenses on behalf of the Paragon Debtors when it “distribut[ed] the corpus of the Litigation Trust Pro Rata to the beneficiaries of the Litigation Trust.” Id. at 5 (internal quotations omitted). Further, all disbursements related to Paragon’s obligations to the beneficiaries of the Litigation Trust occurred in 2017 when Paragon transferred the property into the Litigation Trust. Id. Thus, the initial transfer in 2017 to the Litigation Trust was the “ultimate payment” made by or on behalf of the Debtors and the UST received a quarterly fee at such time. Id. at 6. In finding that the transfer occurred during a prior quarter in which the maximum quarterly fee was paid, the Court noted in a footnote “how offensive” it found the UST’s attempt to “double, or triple, collect its ‘tax.’” Id. In another footnote, the Court noted the “absurdity” of the UST’s position by examining it in the context of distribution of out of the money warrants or stock. Id. at f.n. 30. Any payments by the Litigation Trust to its beneficiaries are by the Trust and “for the benefit of holders of the Litigation Trust Interests,” not on behalf of the Debtors. Id. at 6. Therefore, the Court held that no further fees to the UST were required.
This ruling, albeit a nonprecedential letter ruling, will undoubtedly have impacts for litigation trusts created in other reorganization cases; however, post-sale liquidating plans often also create trusts that are vested with both litigation claims as well as pots of cash and the distributions from those trusts may also be impacted by this ruling. If the transfer of any of a debtor’s assets, cash or claims, to a trust occurs on the effective date and the trust then makes payments to its beneficiaries from the corpus of the trust, then the trust’s subsequent distribution under this ruling would arguably not be “payments by or on behalf of a debtor” subject to U.S. Trustee fees. This would have the practical effect of generating a large, potentially maximum, U.S. Trustee fee for the quarter in which the effective date of a plan occurs with minimum fees for subsequent quarters. For a liquidating debtor who transfers a significant pot of cash to a liquidation trust, this ruling, if applied to such cases, could have the effect of minimizing U.S. Trustee fees on further distributions to creditors, making such structures even more attractive following section 363 sales. As this relates to the funding of the U.S. Trustee program and based on the litigation that has unfolded both in the instant case and related to the statutory increase in such fees, there is likely to be future litigation over this ruling and its application in other cases.
Should you have any questions, please contact Potter Anderson partners Chris Samis (csamis@potteranderson.com) or Katie Good (kgood@potteranderson.com).
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